Basis Risk as Adoption Barrier
Expert TheoryReview
Weather index insurance fails to deliver effective financial protection when rainfall measurements collected at regional weather stations do not correlate accurately with actual crop losses on individual smallholder plots.
Picture this
Imagine buying rain insurance that relies on a weather gauge located twenty miles away at a city airport. A localized drought destroys crops on a farm, but because normal rain fell at the distant airport station, the insurance company refuses to pay out while keeping the farmer's premium.
What the evidence says
36 out of 120 Kebeles (30%) were excluded because dominant risks were non-drought perils (frost and flooding) lacking indices, and another 35 Kebeles were dropped due to incomplete historical station rainfall records required for reinsurance pricing.
- Who was studied
- 120 Kebeles initially selected across 4 zones in Amhara, Ethiopia; reduced to 49 study Kebeles covered by 17 rainfall stations.
- How
- Meteorological station availability and spatial coverage analysis combined with theoretical risk models of index contract design.
What to do
Establish dense weather monitoring networks or satellite remote-sensing indices to minimize spatial and peril mismatch before offering index insurance products to farmers.
From the source
"A product with high basis risk simply fails to achieve the desired goal of providing protection against correlated risks to consumption, and hence is not demanded for perfectly good reasons."
Productivity, credit, risk, and the demand for weather index insurance in smallholder agriculture in Ethiopia